Sperling: Why Fannie Shouldn’t Be Sold Back to Investors

A top economic adviser said Wednesday that Fannie Mae and Freddie Mac aren’t for sale in a bid to squash hopes that the Obama administration would allow the firms to be recapitalized.

Associated Press

Chairman of the National Economic Council Gene Sperling

Gene Sperling, the director of the White House’s National Economic Council, said the administration would not support plans to recapitalize Fannie Mae and Freddie Mac in their current or modified forms because of the difficulty to solve core concerns over having two large entities dominate the nation’s $10 trillion mortgage market.

Mr. Sperling’s remarks follow major moves last week by hedge funds and large investors to up the ante in their campaign to have the U.S. government restore value to the shares of Fannie and Freddie, the mortgage-finance giants that the government bailed out in 2008. Here’s what he had to say about housing policy:

MORTGAGE LENDING STANDARDS: Mr. Sperling became the latest Obama administration official to raise concerns about access to credit for new households:

Nobody wants to go back to the recklessness that led to this crisis but we should recognize the pendulum has swung too far. The credit box is too tight. The FICO score is overly demanding. And that means too many families are locked out of getting mortgages.

THE CASE FOR A FEDERAL HOME-LOAN BACKSTOP: He stressed the importance of preserving a key mortgage-bond market known as the “TBA” or To-Be-Announced market, which allows homeowners to lock in rates on 30-year, fixed-rate mortgages well in advance of closing on those loans:

Most 30-year fixed rate mortgages are pooled and traded in the TBA, or “To-Be-Announced” market. The presence of some form of remote, transparent and explicit backstop is critical to the functioning of the TBA market because it will continue to attract investors who are willing to take on interest rate risk but not credit risk. This is something you would want to preserve.

WHY THE OLD MODEL FAILED: Mr. Sperling laid out his view of why Fannie and Freddie—which are sometimes referred to as government-sponsored enterprises, or “GSEs”—became such dominant market players during the 1990s and early 2000s:

At the core of the failed model of what went wrong is unquestionably the implicit government guarantee of GSE-insured, backed securities and their debt. This implicit guarantee meant that market participants perceived taxpayers would step in and cover any losses at the GSEs even if those companies did not pay for the costs associated with that implicit guarantee. This gave the GSEs important competitive advantages that did not prove to be beneficial for our economy as a whole. The GSEs cost of funding was significantly cheaper than their competitors, which allowed them to crowd out competition. It allowed the GSEs to take on excessive risks without suffering the normal market consequences of higher borrowing costs. And collectively this enabled the GSE to grow into a duopoly in the housing-finance market that made them perceived to be too big to fail. The larger the GSE became, the more this perception of too big to fail and implied government guarantee got strengthened. And this flawed model was exacerbated by the fact that there was a structurally weak regulator that permitted gross undercapitalization of these two firms.

WHO CAUSED THE CRISIS: Mr. Sperling said that Fannie and Freddie poured fuel on the fire but they didn’t start it, a point of heated debate over the last five years:

Now it is important to note that the GSE business models, while fundamentally flawed, were not the lead or primary cause of the foreclosure crisis. Predatory lending, inaccurate credit ratings, regulatory failure, lack of skin-in-the-game by market participants, and much more—“an era of recklessness”—were the primary causes of the housing crisis. But as a result of the GSEs flawed models, when the financial crisis started, rather than being a buffer against the housing downturn, Fannie and Freddie actually contributed to the systemic instability.

WHY THE COMPANIES SHOULDN’T BE RECAPITALIZED: Mr. Sperling said the risks of the companies returning to their old forms would be too great.

Some have suggested that because the housing market is improving an because Fannie and Freddie are profitable again, we do not need comprehensive housing-finance reform, or that you could have reform that would recapitalize these firms in their current corporate form but somehow do so without the implicit government guarantee or without creating a too-big-to-fail duopoly.

I want to make clear our administration believes the risks are simply too great that this model will recreate the problems of the past. I will repeat: we believe the risks are simply too great that this model would create the problems of the past and here’s why. New entrants could rightfully fear that GSEs would have an infrastructure advantage given their legacy pipeline and relationships. The GSEs [information-technology] infrastructure is connected to nearly 2,000 originators. New entrants to the market would have a sensible reason to fear that they would find competing against this structural advantage to be prohibitively costly.New entrants could also have reason to fear that the GSEs would have the economy of scale advantages which would provide higher profit margins and greater ability to undercut competitors on price. And new entrants would also have reason to fear that GSEs would still retain cost of funding advantage given their size relative to smaller competitors even without a government guarantee.

In light of those risks, all of us should fear that we could recreate a duopoly that the market would perceive as too-big-to-fail market entities with an implicit government guarantee—the core of the GSE failed business model we are trying to replace, revamp, and say “never again” to.

THE PROSPECTS FOR BIPARTISAN LEGISLATION: Mr. Sperling applauded the efforts of Sens. Bob Corker (R., Tenn.) and Mark Warner (D., Va.) who took the lead earlier this year on a bipartisan overhaul bill. Sens. Tim Johnson (D., S.D.) and Mike Crapo (R., Idaho), the heads of the Senate Banking Committee, are now working on a similar product:

We were very engaged in helping when asked with the drafting of the Corker-Warner legislation. That doesn’t mean that we agree with every aspect of it, but we saw it as a good and constructive effort and it was worthy of our cooperation. What Sens. Corker and Warner put together is an important start … but ultimately for this bill to happen, we will need the leadership of Chairman Johnson and Ranking Member Crapo. And we are working very closely with them on that. We believe that there is no reason that we should not try to move as quickly as we can to explore the possibilities of how fast we could pass out of the Senate Banking Committee bipartisan legislation.

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